Guest Post: How An Equity Market Prices In Recession

Tyler Durden's picture

Submitted by Tony Pallotta of Macro Story

How An Equity Market Prices In Recession

I'm not going to even begin to try and make sense out of today's market. Watching fires burn and teargas fired in Greece, 100 pip moves in the EUR/USD in minutes and computer algos tripping over each other was surreal beyond words. This market right now is a lottery.  Calling equities forward looking or a pricing mechanism is beyond ridiculous.

It is during noisy times like these that investors must step back and keep things in perspective. Trading on days like today requires little skill and a lot of luck. When I step back I see a deteriorating economy and an equity market trying to understand what to do.  Do they "price in" a soft patch or a full blow recession. Market participants are told it is in fact a soft patch.  The slightest hint of positive data reinforces those views.

Using history as an example I want to share with you the 2007 "soft patch" and how equity markets priced in that economic headwind as well.

Below are a few notable quotes discussing the soft patch which in fact was a recession that began in December 2007 with Q1 2008 the first full quarter of contraction at minus 0.7% from the plus 2.9% in Q4 2007 (my how fast things can change).

  • "We anticipate a soft patch in the middle of next year." - Morgan Stanley December 6, 2007
  • "The economy is in a soft patch right now" - Mike Moran of Daiwa Securities December 23, 2007
  • "Meanwhile, the Goldilocks economy remains alive and well." -  Larry Kudlow January 4, 2008
  • “The Federal Reserve is not currently forecasting a recession. It is however forecasting slow growth” - Fed Chairman Bernanke January 10, 2008

The following side by side comparison of the current SPX and that of December 2007 is messy but "bear" with me as the similarities are rather interesting. This is not an Elliott Wave analysis either. Notice the relationship among Point A, B, C, D and E on both charts.

The two highs of the topping pattern are Point A and C with  C being slightly above A (imagine those technicians declaring a breakout).

The two lows of the corrections are Point B and D with D being slightly above B (imagine those technicians saying we put in a higher low thus bullish for price).

Point E is the question in terms of where we are now.  Using the current trend lines off the 1,370 high SPX 1,320 would be the modern day Point E.

Equity markets struggled in 2007 to price in the recession efficiently and were only two months forward looking.  In this highly leveraged, exuberant and low cash market why are we to think 2011 is any different?

As a reminder of a few other similarities, here you go.

  • We have leverage back at pre Lehman Brother levels
  • We have record low cash levels at mutual funds
  • We have the end of QE2
  • We have forecasts for contraction in Friday's ISM manufacturing based on actual regional manufacturing data for June


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Highrev's picture

Tyler, I think someone else mentioned it earlier, but could you slow down a bit?



Raymond K Hassel's picture

Slow down?  I would have requested the opposite, except it would be rude to ask.

FunkyMonkeyBoy's picture

For f**k sake Tyler, pull your finger out... more updates please, this site is too static. 

The Fonz's picture

That is a terrible idea! Although I would like to say that Tyler(s) have been outputing extrodinarily high quality work at a stunning pace of late! ON A RAMPAGE FOR JUSTICE! 

On a side note: I was saying to a friend of mine that I need to learn as much from Tyler as I can becuase I don't think he will be around after the crisis. He is the kind of person that appears in a time of crisis and fights for us all. The quality and accesibility of this info to my mind cannot simply be a business plan, but there must be a passion behind it that is driven by these times.  Pay attention while you can, if you can aquire a good portion of Tylers skill you will never want for money again in your life, and then you too might be free enough to pick something worthwhile to fight for besides your next paycheck. That is what I hope for!

Thomas's picture

Insert Editorial Comment: I am glad to see you back, Macro Story. We beat ya up pretty badly (and maybe unjustly) on that recent blog. No hard feelings. Just kinda caught a nerve. As Aristotle is reputed to have said, "An educated person can entertain an idea without endorsing it." I guess we go back to school for more education some times.

MacroStory's picture

I knew what kind of kids played in this sandbox before I entered it so no harm done.  This group is nothing compared to the unions I used to work "with" in my old corporate days.

Thomas's picture

Editorial Addendum: First I miss the math problem (sheesh) and then I double post. It's back to school on the short bus.

zKeyserSoze's picture
last week
David Bloom: 'Is There a Bigger Armageddon Out There?'

this week, dollar's in trouble at 5.20 min

Guest Host David Bloom

mynhair's picture

One more day, that should do it.  Just one.

There is No Spoon's picture

How An Equity Market Prices In Recession - it doesn't. In the past, conventional wisdom dictated that the stock market anticipates six months ahead. In the chart it's clear that the market didn't even anticipate two months ahead - it was in the middle of its range when the recession began.

Zero Govt's picture

i'd agree with that ...the US property sector topped in 2006 then turned down.. the US stock markets didn't really nose-dive hard until Q3 2008 so i fail to see how self-annointed 'experts' like Rob Prechter (beaten hands down by a coin toss at market predictions) call the stock indexes "lead indicators". Surely we should look at all sectors for signs of tiring and collapse?

Prechter says the Indexes are "a process" of a number of sectors topping at slightly different times we can safely say the Indexes are an averaging indicator, not a lead indicator, and pretty 'slow to show' given guidence in housing 2 years earlier

the other point Prechter makes is the Indexes are overly positive measures because bankrupt companies get taken out of the Indexes and replaced with still solvent ones so they do not reflect the actual carnage 'dropping' big negative numbers. So the Indexes are a rose-tinted spectecles, much delayed averaging unit of measure, not an accurate sharp as a tac lead indicator then!!

And given the Nasdaq has now retraced 100% of its 2008 to March 2009 decline you have to ask what fuking planet are these Indexes on given the shit-state of everything? Probably coming from the same planet, Uranus, that Prechter and his Elliott Wave muppets come from

statlawyer's picture

looks like someone else has spotted the H&S about to finish off :)   cheers-

steve from virginia's picture


The market is starting to price in the running out of ideas.


Freddie's picture

LOL!  How do you price anything when it is totally corrupt and manipulated everywhere.

JPM, GS, The Fed, BS fake Chinese IPOs, HFT, Arbs, the options and futures exchanges.  The whole thing is a totally corrupt fiat joke.

Jimbo Jones's picture

SH and RWM is how I priced it in... just hope I can find a bigger sucker down the road.

The Fonz's picture

I noticed one way you can price it in.  You see point D on the graph? In 2007 it dipped below the 200 DMA, this time it did not. At first this worried me, then I remembered I had watched the market all day during those times. There were several days where the market was obviously propped up over 780 in the RUT.  This 2011 market would have done the same without manipulation. If you want to price in manipulation I think you can mark those reflection points above the 200DMA as the extent of the ability to manipulate.  It's important to note they can't just pull a number out of their ass and make it happen, they need the market to help them, ie the 200 DMA line. Also you can price in manipulation by the amount of time it works. If for instance JPM whacks silver and sends it straight down with shorts, and it pops right back up to the previous level, they'll have a LOT of shorts they couldn't clear, and they'll back off until they can make a market whackjob stick. Rule of thumb is if they can't get it to hold 50% of the move they falsely make they'll usually back off, at least in the PM markets. All you have to do is remember where they want the manipulation to drive the market and watch out for levels they can drive one way or another and the market will allow them to hold.

mr. mirbach's picture

despite the cyclical nature of history 'tis a pity lessons from the past are never learned. "This time it's different!"

tallen's picture

It's all transitory.


Mr Lennon Hendrix's picture

The dollar is not a safe haven anymore.  Quite bitching and get used to it.

mynhair's picture

Wait 3 hrs and try reposting that.

Mr Lennon Hendrix's picture

Economies have been mired in depression for decades, the dollar has lost its ass to inflation to the end sum, and you want me to do what now?

banksterhater's picture

The withholding tax is back to 1 yr ago, the WLI (ECRI) has been down for how many weeks? 6? The market was all windowdressing, it's not pricing in any caution plus the Mafia is unloading the Cream of the Shit IPOs, if that isn't the end, don't know what is.

Watch initial claims, ISM and next weeks jobs# will be in the toilet.

foxman's picture

When was the last time the FED forecast a recession?

baby_BLYTHE's picture

they never have and always point the finger of blame elsewhere.

Listen to Ron Paul school Benocide on the Great Depression. Ben is a total buffoon.

rocker's picture

Seems to be pretty good stuff.  But, it sure would be nice to see time lines indicated. Please !!!

mynhair's picture

Think it's a weekly chart.

MacroStory's picture

It's a daily chart with the 07 high in October and the current high May. I zoomed in so and cropped out the dates because I already had too much on them. Sorry!

Bob's picture

The symmetry of the two charts is remarkable.  I may need to schedule an eye appointment after that one.  Wow. 

urbanelf's picture

Fuck it.  FAS: ALL IN

mynhair's picture

That's the spirit!  After all, it is a casino.

banksterhater's picture

The PDs buy their own bank stocks to windowdress end of Q, easiest way to move market. You've got a big old gap, and $26 is resistance, good luck if you don't take profits fast enough.

urbanelf's picture

Oh, I'm fast, alright.

Watch this...

... didn't see it, did you?

The Fonz's picture

So its the Elves that run the HFT! I should have known after Alex Jones explained that bit about DMT elves.... That actually explains a lot!

zorba THE GREEK's picture

 We have all the same problems now that we had in 2007, only now they are

 bigger because we didn't address them before. We also have more problems

 now, like Europe meltdown and Mideast uprising and China looks more shaky now.

 We also didn't have Japan's nuclear crisis, which to date hasn't been resolved.

 We are now facing a global financial crisis which is larger and  far reaching

 than that of 2007 and due to massive government debt and insolvent banking

 system, we are in a weaker position to defend the economy and prevent a total












Stares straight ahead's picture

Iambic pentameter or cut and paste?

boiltherich's picture

This is much worse than 1974 and different in so many ways.  For one thing they were not churning billions of shares a day back then with front running computer programs. 

The "market" isn't pricing anything at all, GS, JPM, Citi, a few others, along with FRBNY and Treasury are doing all the pricing.  But what does it matter anymore?  Without a stable dollar nobody could possibly price anything with any assurance of being right, or close to right, and in those circumstance one just prices higher and hopes for the best. 

I have not heard much lately about what market shorts are up to, or disclosures on insider trades, anyone got the quick dirt on those?  Retirement can really slow a guy down.

Bob Paulson's picture

That article assumes that inflation figures are accurate. We all know those figures are as cooked as an Irish stew.

YesWeKahn's picture

Too much money has no where to park. This is the only way.

Freddie's picture

Too much worthless fiat money.

Zeilschip's picture

Let's see what happens if the S&P ends up on July 1st...

carbonmutant's picture

Meredith Whitney: Beware July 1

... she warned that July 1 is going to be a key date for the muni market, because that’s when new state budgets are going to take effect, slashing aid to many localities.

GlassHammer's picture

"Low cash market"

^A good three word summation of the equity market.


PulauHantu29's picture

<<When I step back I see a deteriorating economy and an equity market trying to understand what to do.>>

I am moving more into cash (and gld  slv) every day. "stocks" are super risky right now.

banksterhater's picture

GLD is a buck from resistance, volume in crapper on this move, this will be going MUCH lower. Good luck. Silver is worse, it will go back to 28.

Solarman's picture

With cash, make sure it is not in a European money market fund.  You won't know unless you ask, GLD and SLV are derivative vehicles with a promise to pay.  If their sponsors have financial difficulty you lose.  So be careful.

apberusdisvet's picture

Pulau:  I very very strongly suggest you start putting Harvey Organ on your daily reading list;  he usually posts before 7:30pm est.